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HHS Inspector General: Observation Status is a Growing Problem for Patients

In a new report, Vulnerabilities Remain Under Medicare’s 2-Midnight Hospital Policy,[1] the HHS Inspector General documents and confirms what Medicare beneficiaries and their advocates have seen: long outpatient stays in hospitals are increasing.

How hospitals bill the Medicare program – Part A for inpatient status, Part B for outpatient status – affects Medicare beneficiaries’ entitlement to Medicare and what patients must pay for their hospital and post-hospital care. The consequences of hospitals classifying patient stays as outpatient, rather than inpatient, are most significant for patients who need post-hospital care in a skilled nursing facility (SNF) since Medicare Part A does not cover patients’ SNF care if they do not have a three-day inpatient hospital stay.  Outpatient status also affects patients’ hospital bills.  Patients must pay for medications while they are in the hospital (unless payment is waived by the hospital), and if they do not have Medicare Part B, they must pay out-of-pocket for the entire hospital stay.  

The 2-Midnight Policy

In 2014, the Centers for Medicare & Medicaid Services (CMS) implemented a 2-midnight policy.[2]  This time-based policy establishes that inpatient admission is generally appropriate, and should be ordered, when a physician anticipates that a patient will be hospitalized for two or more midnights.[3]  If the physician is uncertain or anticipates a shorter period of hospitalization, the policy directs the physician to classify the patient as an outpatient – regardless of the patient’s status and where in the hospital the patient receives care.  The CMS policy also confirms that the physician can order whatever care the patient needs.[4] 

CMS intended that the new 2-midnight policy would serve two purposes – reducing short inpatient stays that should have been classified as outpatient (saving Medicare money because hospital care paid on an inpatient basis generally costs more than hospital care paid on an outpatient basis) and reducing long outpatients stays (helping beneficiaries get SNF coverage).  CMS estimated that more patients would be classified as inpatients under the 2-midnight rule.[5]  Not all of these intentions and estimates were realized.

Hospital Classifications of Patients

Reviewing hospital claims data under Medicare Part A and Part B with dates of service in Fiscal Years (FYs) 2013 and 2014, the Inspector General found that hospital inpatient stays decreased by 2.8% (262,794 stays) but that hospital outpatient stays increased by 8.1% (158,908 stays) between FY 2013 and FY 2014.[6]   This finding contradicts CMS’s expectation that inpatient stays would increase as a result of the 2-midnight rule.[7]

Moreover, short inpatient stays (stays of fewer than two days) decreased considerably more than long outpatient stays (stays exceeding two days).  Specifically, short inpatient stays decreased by 9.9%, while long outpatient stays decreased by only 2.8% (and short outpatient stays increased by 11.6%).[8]

Long Outpatient Stays

The Inspector General describes as “somewhat unexpected” the finding that hospitals billed “a significant number – 748,337” of long hospital stays as outpatient.[9]  Most of these long outpatient stays – 633,148 – were for three or more days.[10]

In FY 2014, 432,740 patients were outpatients for some time and then were admitted as inpatients.[11]  This category of patients increased by 20% between FY 2013 and FY 2014.[12]  The remaining 200,408 outpatients were hospitalized for three or more midnights and were never admitted as inpatients at any time during their hospitalizations.[13]  None of these 432,740 long-stay outpatients could have qualified for Medicare Part A coverage of any SNF stay because coverage requires at least three consecutive days as an inpatient.[14]  Patients admitted to inpatient status for two nights following two nights as an outpatient do not qualify for SNF coverage because only inpatient admission days are counted in meeting the three-day requirement.

Hospitals’ Varied Admitting Practices

The Inspector General also finds that hospitals’ use of outpatient status varied, but outpatient stays increased significantly.  In FY 2014, 51% of hospitals actually increased their use of long outpatient stays (and 18% of hospitals increased their use of short inpatient stays).[15]

Inpatient and Outpatient Care are the Same

The Inspector General finds that the care provided to patients, whether classified as inpatient or outpatient, is similar.  He reports that “the most common reasons for short inpatient stays were similar to the most common reasons for short outpatient stays.”[16]  Four of the six most common reasons for hospitalization were the same for inpatient and outpatient stays, although Medicare payments, based on patient status, varied considerably.[17]

Beneficiaries Paid More for Outpatient Care

In FY 2014, 352,940 outpatients paid more in Part B copayments than the inpatient deductible would have been for their hospital stay if they had been classified as inpatients.  The number of patients in this category increased by 16% (almost 50,000 patients) between FY 2013 and FY 2014.[18]

Outpatients Billed by Hospitals for Medications

In FY 2014, patients in 1,628,628 outpatient stays were charged an average of $207 for their medications.  The total charges for medications for these patients was $337 million, which would not have been charged if they had been considered “inpatients.”[19]

Short Inpatient Stays Continue

In FY 2014, hospitals billed Medicare for 1,074,267 short inpatient stays.  The Inspector General estimates that 39% of these stays were “potentially inappropriate” for inpatient status.[20]


The Inspector General makes four recommendations, all of which CMS accepts.[21]  The Recommendations are:

  1. “Conduct routine analysis of hospital billing and target for review the hospitals with high or increasing numbers of short inpatient stays that are potentially inappropriate under the 2-midnight policy.”
  2. “Identify and target for review the short inpatient stays that are potentially inappropriate under the 2-midnight policy.”
  3. Analyze the potential impacts of counting time spent as an outpatient toward the 3-night requirement for SNF services so that beneficiaries receiving similar hospital care have similar access to these services.”
  4. “Explore methods for protecting beneficiaries in outpatient stays from paying more than they would have paid as inpatients.”[22]

The third Recommendation – counting outpatient time towards meeting the three-day rule for SNF coverage – is, essentially, what legislation introduced in the 114th Congress – the Improving Access to Medicare Coverage Act, H.R. 1571, S. 843 – would have provided.

While accepting the third recommendation, CMS states that it lacks authority to count the time.  The Center for Medicare Advocacy disagrees.  In a June 2014 memorandum, written at CMS’s request, the Center demonstrated that CMS has authority to count all time in the hospital towards meeting the three-day inpatient requirement.[23]


The classification of hospitalized patients as outpatients is shifting the costs of hospital care from Medicare Part A to patients, their families, and Medicare Part B.  To the extent that patients in nursing facilities are denied Medicare coverage for their post-hospital care and, consequently, become eligible more quickly for Medicaid, hospitals’ billing practices are also shifting costs to state Medicaid programs.

Beginning March 8, 2017, hospitals will be required to give patients in Observation Status a federal notice – the Medicare Outpatient Observation Notice (MOON) – informing them of their non-inpatient status and the financial implications for their hospital and post-hospital care.[24]  The MOON does not give patients any rights to appeal.  As patients receive the MOON and oral notice of their status, more people will become aware of how hospitals’ Medicare billing practices are directly affecting them.

It is past time for this problem to be addressed and corrected. At the very least, CMS should recognize, and use, its authority to count all hospital time toward the three-day requirement for Medicare SNF coverage.

January 4, 2017 – T. Edelman


[1] OEI-02-15-00020 (Dec. 2016), [hereafter OIG, Observation Status].
[2] 78 Fed. Reg. 50506 (Aug. 19, 2013).  The final rules are discussed in Center for Medicare Advocacy, “Observation Status: New Final Rules from CMS Do Not Help Medicare Beneficiaries,” (CMA Alert, Aug. 29, 2013),
[3] 42 C.F.R. §412.3(d)(1).
[4] For example, in proposed revisions to its “two midnight rule” (allowing physicians to order shorter inpatient stays, now 42 C.F.R. §412.3(d)(3)), CMS confirmed that the two-midnight rule “does not prevent the physician from ordering or providing any service at any hospital, regardless of the expected duration of the service” and “does not override the clinical judgment of the physician regarding the need to keep the beneficiary at the hospital, to order specific services, or to determine appropriate levels of nursing care or physical locations within the facility.”  80 Fed. Reg. 39199, 39349, 39350 (July 8, 2015), Center for Medicare Advocacy, “Proposed Revisions to ‘Two-Midnight’ Rule Provide Little, If Any, Relief for Medicare Beneficiaries Stuck in the Hospital in Observation Status” (Alert, July 9, 2015),
[5] 78 Fed. Reg. 27485, 27649 (May 10, 2013).
[6] OIG, Observation Status, supra note 1, 9.
[7] 78 Fed. Reg. 27485, 27649 (May 10, 2013).
[8] OIG, Observation Status, supra note 1, 9, Figure 2.
[9] Id. 12.
[10] Id. 13.
[11] Id.
[12] Id.
[13] Id. 13-14.
[14] 42 U.S.C. §1395x(i); 42 C.F.R. §409.30(a)(1).
[15] OIG, Observation Status, supra note 1,15.
[16] Id. 11.
[17] Id.  The four most common reasons for short inpatient and short outpatient stays were coronary stent insertion, fainting, digestive disorders, and chest pain.
[18] Id. 13.
[19] Id.
[20] Id. 10.  The Inspector General describes the inpatient stays as “potentially inappropriate” because only medical review could confirm whether the stays were actually inappropriate for inpatient status.
[21] Id. 16-18, 29-31.
[22] Id. 16-18.
[23] The memorandum is available at
[24] See Center for Medicare Advocacy, “Hospitals Must Give Patients Notice of Their Observation Status, Beginning March 8, 2017” (CMA Alert, Dec. 14, 2016),

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